How to Trade Options Before Earnings in Broadcom (AVGO)

[Ophir Gottlieb]

 

How to Trade Options Before Earnings in Broadcom Limited (NASDAQ:AVGO)

 

How to Trade Options Before Earnings in Broadcom Limited (NASDAQ:AVGO)

Date Published: 2017-05-15 

PREFACE 
Trading options in a short window before earnings are released benefits from the rising implied volatility but avoids the risk into the actual earnings release and also avoids any kind of stock direction risk. 

This approach has returned a annualized rate of 198%. Now that's worth looking into. 

STORY 
Everyone knows that the day of an earnings announcement is a risky event for a stock. This can be explicitly seen in the option market, where the implied volatility (the expected stock move) rises into the earnings event. 

The question every option trader, whether professional or amateur, has long asked is if there is a way to profit from this known volatility rise. It turns out, that over the long-run, for stocks with certain tendencies like Broadcom Limited (NASDAQ:AVGO) the answer is actually, yes. 
 

Yes, there is a systematic way to trade this repeating phenomenon, without making a bet on earnings or stock direction.

THE SET UP 
What a trader wants to do is to see the results of buying an at the money straddle a few days before earnings, and then sell that straddle just before earnings. The goal, is two-fold: (i) to benefit from that known implied volatility rise, and (ii) to own the straddle for a very short period of time when the stock might move 'a lot,' but taking no earnings bets. 

If either of those two phenomena occur, there's a very good chance this wins, if neither occur, the amount risked is normally quite small. Here is the setup: 
 

We are testing opening the position 6 days before earnings and then closing the position 1 day before earnings. This is not making any earnings bet. This is not making any stock direction bet. 

Once we apply that simple rule to our back-test, we run it on an at-the-money straddle: 

RETURNS 
If we did this long at-the-money (also called '50-delta') straddle in Broadcom Limited (NASDAQ:AVGO) over the last three-years but only held it before earnings we get these results: 
 

Long At-the-Money Straddle
* Monthly Options
* Back-test length: three-years
* Open 6-days Before Earnings
* Close 1-day Before Earnings
* Holding Period: 5-Days per Earnings
Winning Trades:		5
Losing Trades:		7
Pre-Earnings Straddle Return:		17.1%
Annualized Return:		102%

We see a 17.1% return, testing this over the last 12 earnings dates in Broadcom Limited. That's a total of just 60 days (5 days for each earnings date, over 12 earnings dates). That's a annualized rate of 102%. 

We can also see that this strategy hasn't been a winner all the time, rather it has won 5 times and lost 7 times, but here's the key -- it wins about half of the time, but the average gain per winning trade is substantially larger than the average loss on a losing trade: 
 

Consistently Successful 
This idea has also been a successful approach over the last two-years:

Long At-the-Money Straddle
* Monthly Options
* Back-test length: two-years
* Open 6-days Before Earnings
* Close 1-day Before Earnings
* Holding Period: 5-Days per Earnings
Winning Trades:		4
Losing Trades:		4
Pre-Earnings Straddle Return:		22%
Annualized Return:		198%

Now we see a 22% return, testing this over the last 8 earnings dates which is a annualized rate of 198%. 

Yet again, we see a trade that wins about half the time, but the average win is much larger than the average loss: 
 

If you really want to see how we found this, and how to do it for other stocks like Apple, Google and Amazon, here is a 1-minute and 34-second video that every professional option trader would rather that you don't see. 

Learn more here: Try the Back-tester Yourself

WHAT HAPPENED 
There are patterns to stock behaviors before and after earnings and those patterns reveal opportunities in the option market, without taking the actual risk of earnings. You can find them, stock by stock. This is how people profit from the option market -- it's preparation, not luck. 

To see how to do this for any stock we welcome you to watch this quick demonstration video: 
Tap Here to See the Tools at Work

Thanks for reading. 

Risk Disclosure 
You should read the Characteristics and Risks of Standardized Options. 

Past performance is not an indication of future results. 

Trading futures and options involves the risk of loss. Please consider carefully whether futures or options are appropriate to your financial situation. Only risk capital should be used when trading futures or options. Investors could lose more than their initial investment. 

Past results are not necessarily indicative of future results. The risk of loss in trading can be substantial, carefully consider the inherent risks of such an investment in light of your financial condition. 

Back-test Link

 

 

 

 

 

 

 

 

[Yowster]

@Ophir GottliebRequest - In these writeups could you include the setting for Execution Fill Type (or better yet a link to the actual test scenarios)?  As you may be getting to know, I like to drill into the individual trade detail to get a complete picture of what was going on.  I was having difficulty duplicating your test scenario until a found the difference.   If you run the scenario with Execution Fill Type set to halfway between mid and market (the tool's default value), the 5-7 win/loss with +17.1% return drops way down to 2-10 win/loss with -28.7% return.   When I switched to Mid Market my test results matched those published.   I don't believe the intent was to have these 2 setting produce that drastic of a difference but I guess when you have wider bid/ask spreads it can happen.   I do think the Mid Market setting would be much closer to actual results, although probably with few cents of slippage from the mid.

[Ophir Gottlieb]

23 hours ago, Yowster said:

@Ophir GottliebRequest - In these writeups could you include the setting for Execution Fill Type (or better yet a link to the actual test scenarios)?  As you may be getting to know, I like to drill into the individual trade detail to get a complete picture of what was going on.  I was having difficulty duplicating your test scenario until a found the difference.   If you run the scenario with Execution Fill Type set to halfway between mid and market (the tool's default value), the 5-7 win/loss with +17.1% return drops way down to 2-10 win/loss with -28.7% return.   When I switched to Mid Market my test results matched those published.   I don't believe the intent was to have these 2 setting produce that drastic of a difference but I guess when you have wider bid/ask spreads it can happen.   I do think the Mid Market setting would be much closer to actual results, although probably with few cents of slippage from the mid.

The link is always included at the bottom of the article.

[Ophir Gottlieb]

 

The Staggering Reality of Option Trading in Alibaba Group Holding Ltd

 

Date Published: 2017-05-16 

PREFACE 
Alibaba Group Holding Ltd (NYSE:BABA) stock has been on tear, up 56% in the last year, but a risk managed option strategy has so outperformed the stock it's almost unbelievable. 

OPTION TRADING 
Selling an out of the money put spread is an investment that wins if the underlying stock "doesn't go down a lot." It sounds boring, but it has been a powerful tool with Alibaba Group Holding Ltd (NYSE:BABA) -- but only for the clever trader. 

Here is how selling an out of the money put spread every month has done over the last three-years: 
 

 
Back-test Link

If that return looks low, it is. The stock has actually been up 35% in the last three-years. But this isn't the trade the professionals make, this is the trade the amateurs make. 

What we need to do is measure the impact of earnings announcements on this strategy by adjusting our settings, like this: 
 

Once we add this change, the results are staggering. Here are the three-year results for this option trade, now: 
 

We have taken a 16.9% return and seen it rise to over 100%, and all we really did was take less risk. The 105% return in three-years has nearly tripled the stock and avoided all of the risk of earnings, while simply investing in the idea that Alibaba Group Holding Ltd "won't go down a lot." 

CONSISTENT OVER TIME 
We can do this exact test over the last two-years, as well: 
 

We see a 9.2% return turned into a 47.8% return, or about a 5-fold increase by taking less risk. Again, this option investment has outperformed the stock, as well. 

Finally, we can look at the last year: 
 

Selling an out of the money put spread but avoiding earnings has returned 116% in the last year, versus a stock rise of 56%. 

WHAT HAPPENED 
This is how people profit from the option market -- it's preparation, not luck. 

To see how to do this for any stock we welcome you to watch this quick demonstration video: 
Tap Here to See the Tools at Work 

Thanks for reading. 

Risk Disclosure 
You should read the Characteristics and Risks of Standardized Options. 

Past performance is not an indication of future results. 

Trading futures and options involves the risk of loss. Please consider carefully whether futures or options are appropriate to your financial situation. Only risk capital should be used when trading futures or options. Investors could lose more than their initial investment. 

Past results are not necessarily indicative of future results. The risk of loss in trading can be substantial, carefully consider the inherent risks of such an investment in light of your financial condition. 

Back-test Link

 

 

 

 

 

 

[dfwjf92jfd]

Hi Ophir - 

Thanks for the write-up! I was curious to test this out myself, and I spent some time trying to reproduce your results. I had a lot of trouble doing this until I realized that the settings you used assumed you could buy and sell at the midpoint of the bid-ask spread. I had my settings initially set to buy and sell at market...this made a rather dramatic difference in the outcome:

Parameters

• Long AVGO 50-50 straddle
• 2 year backtest
• 30 day options
• Buy 6 days before earnings, sell 1 day before

Fill Type: Mid-Market

• Total Return: 45.6%

Fill Type: Market

• Total Return: -33%

I was shocked at how sensitive the result was to this one parameter. Do you think it's a bit unrealistic to expect you can get your orders filled at the average bid-ask? Sometimes I'm able to do this, sometimes not. But because it is so critical, I'd suggest listing it as one of the parameters of the trade in the write-up.

Moreover, I think this would be a great topic to do a post about since people who are used to trading highly liquid securities with tight bid-ask spreads might be totally clueless about how this is different for options...

Thanks again and keep up the interesting ideas!